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Monopoly power and the firm’s valuation: a dynamic analysis of short versus long-term policies

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  • Suleyman Basak

    ()

  • Anna Pavlova

    ()

Abstract

Recent anti-trust cases exacerbated the concerns of investors regarding the effects of a firm’s monopoly power on its production choice, shareholder value, and the overall economy. We address this issue within a dynamic equilibrium model featuring a large monopolistic firm whose actions not only affect the price of its output, but also effectively influence the valuation of its stock. The latter renders time-inconsistency to the firm’s dynamic production choice. When the firm is required to pre-commit to its strategy, the ensuing equilibrium is largely in line with the predictions of the textbook monopoly model. When the firm behaves in a time-consistent manner, however, the predictions are strikingly at odds. The trade-off between current profits and the valuation of future profits induces the firm to increase production beyond the competitive benchmark and cut prices. This policy may result in destroying shareholder value, and does indeed fully wipe out the firm’s profit in the limit of the decision-making interval shrinking to zero, in line with the Coase conjecture. Copyright Springer-Verlag Berlin/Heidelberg 2004

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Bibliographic Info

Article provided by Springer in its journal Economic Theory.

Volume (Year): 24 (2004)
Issue (Month): 3 (October)
Pages: 503-530

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Handle: RePEc:spr:joecth:v:24:y:2004:i:3:p:503-530

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Keywords: Monopoly; Asset pricing theory; General equilibrium; Short-sighted; Time-consistency; Coase conjecture.;

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Cited by:
  1. Matthew Pritsker, 2005. "Large investors: implications for equilibrium asset, returns, shock absorption, and liquidity," Finance and Economics Discussion Series 2005-36, Board of Governors of the Federal Reserve System (U.S.).
  2. Basak, Suleyman & Pavlova, Anna, 2004. "Monopoly Power and the Firm€ٳ Valuation:," Working papers 4234-01, Massachusetts Institute of Technology (MIT), Sloan School of Management.
  3. Branko Urosevic, 2001. "Moral hazard and dynamics of insider ownership stakes," Economics Working Papers 787, Department of Economics and Business, Universitat Pompeu Fabra, revised Oct 2004.

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